RSS feedsThe US Fed slashed its key interest rate by 125 basis points over a period of eight days in January. This remarkable policy easing confirmed that immediate threats to growth override inflation risks at present. We will not know for some time whether the Fed was right, or whether it panicked and misjudged the situation. The fraud at Société Générale may have influenced the timing. But the Fed’s moves reflect deep conviction that forceful action is needed to avoid recession. The contrast with Europe is striking.
Rates
Since the credit crisis started last August, the ECB has kept its key rate
unchanged at 4%, while the Fed has cut rates from 5.25% to 3%. Eurozone
official interest rates, after being for two years persistently lower than those
in the US, are now 100 basis points higher. The gap in rates will widen further
before it starts narrowing. The Fed is determined to continue easing, and its
key rate could reach 2.5% before mid-2008.
The ECB remains concerned with inflation, but has acknowledged that slower eurozone growth justifies modest easing. The markets expect a cut to 3.75% in April. The UK has cut Bank rate in February from 5.50% to 5.25%. Most analysts expect UK rate cuts to 4.75% by mid-2008, but the forward market signals bigger falls.
Currency
The US dollar has weakened sharply in 2007, driven by fears that US growth is
set to plummet and by lower US rates since August. But the dollar has risen in
recent weeks, even though interest rate relativities have moved sharply against
the US. The dollar remains vulnerable. But there has been a critical change.
The markets now believe that, though the US economy will weaken in the near term, measures taken by the Fed and the Administration will ensure that the downturn is brief. In 2009 and beyond, US growth prospects are certainly stronger than those of the eurozone and Japan. It is particularly important for the Chinese yuan to strengthen. But a dangerous dollar rout is unlikely in 2008, and this is good news for the global economy.
